Increasing Risk
Concerns are growing over short-term investment by foreigners in the South Korean bond market. Their bond holdings exceeded 105 trillion won in 2015, fell to 99.1 trillion won in May last year, began to increase late last year and broke the 100 trillion won mark again on April 11 this year. Short-term bonds constitute a pretty large portion of the bonds they hold now. This means they can leave the market anytime in the event of an additional interest rate hike in the United States or due to geopolitical risks surrounding the Korean Peninsula.
It is Asian funds that are currently leading the increase in bond investment mentioned above. “These days, China is opening its bond market and internationalizing its currency and won-denominated bonds have become a useful investment diversification tool in that context,” said a market participant. According to the Financial Supervisory Service, foreign bond investors recorded a net going public bond purchase of 2.607 trillion won last month and monetary stabilization bonds with relatively shorter maturities took up 85% of the amount. When it comes to government bonds, which constitute 77% of their total bond holdings, their net sale totaled 300 billion won last month.
At present, 24.9% of their bond holdings are those with a maturity of less than one year and 49.6% are those with a maturity of one to five years. The duration of their bonds recently fell from 3.9 years to 3.7 years, too.
This increase in their short-term investment in the South Korean bond market has to do with arbitrage prior to the U.S. interest rate hike in the first quarter of this year. In other words, the foreign investors have invested in the bonds in order to profit from the relatively lower value of the South Korean currency as well as an interest rate difference. According to market experts, their investment has increased by approximately 10 trillion won since the beginning of this year and the inflow in February based on arbitrage accounts for 60% of it.
“This can negatively affect the stability of the local bond market in that short-term investors can quickly leave it once they witness an increase in global financial uncertainties and the local bond market has yet to provide more diverse investment structures capable of holding them in that case,” one of them pointed out, adding, “Besides, China may sell won-denominated bonds to protest against the South Korean government’s decision to accept THAAD deployment.”